Europe past the peak of pessimism
The terraces open again. Suddenly, the telephone rings red-hot in various hospitality establishments. There are too few tables and too many people want to reserve a seat. The Italians have the solution. In cities like Florence and Venice, you pay for a table, usually per half hour. The hospitality industry can use a financial boost, let’s see if it works in here too. That the hospitality industry in Europe is opening up can also be seen from the rising interest rates. Suddenly it is rising in Europe, but at the same time, it has stopped rising in the United States. Apparently, growth expectations for this year have been sufficiently revised upwards in the United States, but there is still upward potential in Europe.
The first quarter was the worst quarter for US Treasuries since 1980. In Europe, the damage to the bond market was less severe. The main cause was the difference in the pace of vaccination. In the United States, vaccination was much faster than expected, but in Europe, there were many delays that even led to new restrictive measures being taken. Moreover, the Federal Reserve had no problem with rising interest rates, while in Europe Lagarde immediately went ahead with an increase in the Pandemic Emergency Purchase Programme (PEPP) to push down long-term interest rates. In that respect, Lagarde has learned a lot. A year ago she made the mistake of saying that the ECB was not there to reduce interest rate differentials. A year later, the ECB has succeeded admirably.
The speed of vaccination in the United States was the big positive surprise in the first quarter. That surprise now seems to have been priced into stock prices. It is possible that Europe could produce a similar surprise in the second quarter. The market is eagerly looking for another positive surprise. Europe is a suitable candidate because Europe is accelerating its vaccination programmes. Last week, Germany set a record of 719,000 vaccinations a day. Furthermore, European citizens are getting better at coping with restrictive measures. According to Google’s mobility data, European activity is recovering strongly, despite new lockdowns. The recovery is underway. The IHS Markit eurozone PMI rose from 57.9 to 62.4, the highest level since 1997. This is mainly due to a strong increase in export orders.
Because interest rates are not rising further in the United States, but they are in Europe, the transatlantic interest rate differential is narrowing. In the first quarter, the 10-year spread widened from 1.5 percent to over 2 percent, but since mid-April the trend has reversed. In the first quarter, the US dollar still profited from this rising interest rate differential, but now the euro is gaining ground thanks to the recovering European economy. However, do not expect such a spectacular rise in interest rates as in the United States. The rise in interest rates in the United States was not only caused by the vaccinations but mainly by the sharp rise in inflation expectations. In Europe, the rise in inflation expectations is more moderate. However, not all the optimism seems to be reflected in bond prices.
The dilemma for Europe remains the diverging euro. The European currency is not a unifying factor but is driving countries apart. Fortunately, the biggest risks have been immunized in the short term by the deployment of Super Mario as Italy’s prime minister, but that does not mean that the European political project will not be vulnerable in the coming 12 months. The euro was created by politics and will be destroyed by politics. That requires a recession, the moment when voters can put Eurosceptics in the saddle. First, we have the elections in Germany. At the moment, the German Greens can count on 28% of the votes, while CDU/CSU remains stuck at 21%. This leadership of the Greens could also have a very positive impact on the European Green Deal. The risk is much greater in the French elections in 12 months’ time. Le Pen is ahead of Macron in the polls. The traditional Republican front against the radical right has crumbled. Voting for Marine Le Pen is widely accepted post-Corona. Still, it will not be easy for Le Pen to gain a majority (let alone many seats) in parliament, but should she succeed, a 76-page Manifesto for the European Alliance of Nations leaves no stone unturned for the European institutions. Even without a radical right-wing French parliament, the Berlin-Paris axis will look very different. But pessimism in Europe has peaked and Macron stands to gain from a strong economic recovery, even if it means a further rise in interest rates.